Audit quality – The role of directors and audit committees

This is Information Sheet 196 (INFO 196). It is relevant to audit committee members and to directors, whether or not they are members of a company’s audit committee.

It explains:

why audit quality is important
the auditor's responsibilities
the roles of directors and audit committees
the directors' responsibilities for auditor independence
who should manage the appointment of auditors
what matters should be considered when setting audit fees
the features of audit committees that support audit quality
how directors and audit committees can promote audit quality
possible reporting considerations for directors

Why is audit quality important?

Auditors play a critical role in ensuring that Australian investors can be confident and informed when making investment decisions. High-quality audits support the quality of financial reports and enable investors to rely on the auditor’s independent assessment of financial reports.

Audit quality relates to matters that affect the auditor's ability to achieve an audit's fundamental objective: to obtain reasonable assurance that the financial report as a whole is free of material misstatement. Auditors must ensure any deficiencies detected are addressed or communicated through the audit report.

Note: This view is consistent with the objective of the audit, as outlined in paragraph 11 of Auditing Standard ASA 200 Overall objectives of the independent auditor and the conduct of an audit in accordance with Australian auditing standards.

Audit quality can be influenced by such factors as:

an audit firm's culture and focus on audit quality, professional scepticism and consultation
the auditor's understanding of the business and the risks affecting the financial report
the internal and external experience and expertise applied in audits (including recruitment and training, the use of experts, and specialist industry knowledge)
how effectively audit engagements are supervised and reviewed (including audit firm quality reviews)
the audit firm's system of accountability of engagement partners and others in the firm for audit quality (e.g. impact on remuneration for poor internal quality review findings).

What are the auditor's responsibilities?

Under the Corporations Act 2001 (Corporations Act), the auditor must:

form an opinion about whether the financial report complies with the accounting standards and gives a true and fair view, as well as about certain other matters (section 307) and report to members (section 309)
conduct their audit in accordance with the auditing standards (section 307A)
meet independence requirements (including professional standards) and give the directors an auditor’s independence declaration (section 307C), and
report certain suspected contraventions of the Corporations Act to ASIC (section 311).

What are the roles of directors and audit committees?

An audit committee is a committee of the board of directors that focuses on issues relevant to the integrity of the company’s financial reporting. The ASX Listing Rules require certain listed entities to have audit committees. Other companies may choose to have an audit committee.

While the existence of an audit committee does not alter the need for directors to take responsibility for financial reports, audit committees can play an important role in the financial reporting process and in supporting and promoting audit quality.

The auditor gives an independent opinion that follows after the directors’ opinion on a financial report. A company must have its own systems, processes and controls, as well as appropriate resources, to produce high-quality financial reports. Directors must not rely on the auditor when forming their own opinion on the financial report, as this would undermine the objective of an audit, which is to provide independent assurance to members on the financial report. See also Information Sheet 183 Directors and financial reporting (INFO 183).

Audit committees should consider raising with the board of directors any audit quality concerns that are not satisfactorily resolved with the auditor. Directors and audit committees may seek advice where appropriate, and may raise concerns with ASIC if needed.

See also Regulatory Guide 260 Communicating findings from audit files to directors, audit committees or senior managers (RG 260). This guide explains which financial reporting and audit quality findings identified from our reviews of audit files we will generally communicate to directors, audit committees or senior managers. It also explains the process we will follow and the timing of our communication.

What are the directors' responsibilities for auditor independence?

The independence of the auditor is important for promoting market confidence in the auditor’s report on the financial report. Actual and perceived independence from directors and company management, as well as the objectivity of the auditor, underpins audit quality.

The directors’ role in ensuring the independence of the auditor is illustrated by the requirements in the Corporations Act that the directors’ report include:

the auditor’s independence declaration, and
for a listed company, a statement about whether the provision of non-audit services by the auditor during the financial year is compatible with the general standard of auditor independence in the Corporations Act, and whether that statement is consistent with the advice of the audit committee (section 300(11B)–(11E)).

It is important for directors and audit committees to consider the independence of the auditor – both when recommending the appointment of auditors and on an ongoing basis.

Who should manage the appointment of auditors?

The members of a public company appoint the auditor at an annual general meeting (AGM): section 327B. If a vacancy occurs in the office of auditor, the directors must appoint an auditor to fill it, but the ongoing appointment occurs at the next AGM: section 327A and 327C.

Because it is generally not practical for members of larger listed companies to be involved in a detailed assessment of auditors and the determination of audit fees, the audit committee and directors can play an important role in recommending the appointment of an auditor.

It is possible that company management may have interests that are not fully aligned with the conduct of quality audits, and so may not be best placed to assess auditors and set audit fees. For example, incentives for management to achieve certain levels of financial performance may lead to setting low audit fees that could place undue pressure on audit quality.

While consideration should be given to any management concerns with audit quality, non-executive directors – who focus on the need for audit quality and who have direct accountability and fiduciary responsibilities to the company – should ideally manage the process of appointing and replacing auditors and determining their remuneration.

What should be considered when setting audit fees?

A company is required to pay the auditor's reasonable fees and expenses: section 331. Setting audit fees is a commercial decision by companies and their auditors. The process should be managed by the directors (who should be responsible for setting the overall fee) and the audit committee. Directors and audit committees should ensure that audit fees are not set at a level that could lead to audit quality being compromised.

There may be a temptation to reduce audit fees in the pursuit of general cost reductions. However, audit fees are usually a small proportion of costs, and reducing them does not generally have a significant impact on a company’s profit.

Auditors may be faced with challenging judgements in areas such as assessing whether a company is a going concern, impairments of assets and fair values. This increases the time spent on an audit and might be expected to increase audit fees. Changes in the company’s business, reporting requirements or the risks affecting financial reports may also warrant increases in fees.

If a company decides to seek tenders for audit services, the primary focus should be on audit quality rather than on reducing costs. A quality audit supports the quality of financial reporting.

Some audit firms may offer discounted fees to maintain or increase revenues, contribute to fixed costs, occupy staff during downturns, maintain or build market share, or build a presence in a particular industry. In some cases, an auditor may not have understood the company’s business, reporting requirements and the extent of audit work required.

While there may be instances where an effective but more efficient audit can be obtained for a lower fee, audit committees and directors should be aware of pressures in some audit firms to limit the impacts of low or reduced fees on margins. Inadequate fees can create a risk that audit quality is compromised and that auditors do not obtain sufficient and appropriate audit evidence to support their opinion.

What features of audit committees support audit quality?

Features of audit committees that may help a committee to be more effective in promoting and supporting audit quality are listed in the table below. These good practices are based on the IOSCO report on good practices for audit committees in supporting audit quality, January 2019.

Matter	Consideration
Features of audit committees	Does the audit committee comprise only non-executive directors? Has consideration been given to whether all or a majority of audit committee members and the chair should be independent with respect to matters such as financial and business interests with the company and length of tenure? Does at least one member of the audit committee, preferably the chair, have a good knowledge of financial reporting and/or audit (including accounting, auditing and auditor independence requirements)? Do audit committee members as a whole have an appropriate understanding of financial reporting and audit, and knowledge of the industry in which the company operates? Is there introductory and periodic ongoing training for audit committee members in financial reporting, audit and the industry in which the company operates to ensure their capabilities and skills are appropriate and up to date? Does the audit committee chair have demonstrated leadership qualities, strong communication skills, and knowledge of the duties and responsibilities of the position? Has consideration been given to whether members of the board of directors and audit committee have the necessary skills and diversity to discharge their responsibilities? Do audit committee members maintain professional scepticism and a questioning attitude towards the information received from management and in considering the quality of the audit? Has consideration been given to how often the audit committee should meet to satisfy its responsibilities on a timely basis? Regard may be given to factors such as the annual and interim financial reporting processes, the audit committee’s role in the entity meeting certain market disclosure obligations (e.g. any continuous disclosure obligations), the complexity of the business, and assessing whether non-audit services provided by an auditor may compromise their independence. In some cases, ad hoc meetings, teleconferences or email exchanges may also be considered. Does the audit committee have a mandate that permits it to carry out its responsibilities free of any unreasonable restraints? Does the audit committee have support of a secretary or other appropriate resources for its role? Does the audit committee have sufficient capacity for its roles, and to be effective in its role in relation to financial reporting and audit quality? Is there an open internal dialogue within the audit committee? Are all audit committee members encouraged to ask questions, express their views, be heard and have their views considered? Is the audit committee the key representative body with which the external auditor interacts? Does the audit committee report to the full board on the audit committee’s activities to support audit quality, including how issues raised by the auditor were addressed? Does the audit committee conduct peer assessments of the performance of each of its members and assessments of its own effectiveness?

Matter

Consideration

Features of audit committees

Does the audit committee comprise only non-executive directors?
Has consideration been given to whether all or a majority of audit committee members and the chair should be independent with respect to matters such as financial and business interests with the company and length of tenure?
Does at least one member of the audit committee, preferably the chair, have a good knowledge of financial reporting and/or audit (including accounting, auditing and auditor independence requirements)?
Do audit committee members as a whole have an appropriate understanding of financial reporting and audit, and knowledge of the industry in which the company operates?
Is there introductory and periodic ongoing training for audit committee members in financial reporting, audit and the industry in which the company operates to ensure their capabilities and skills are appropriate and up to date?
Does the audit committee chair have demonstrated leadership qualities, strong communication skills, and knowledge of the duties and responsibilities of the position?
Has consideration been given to whether members of the board of directors and audit committee have the necessary skills and diversity to discharge their responsibilities?
Do audit committee members maintain professional scepticism and a questioning attitude towards the information received from management and in considering the quality of the audit?
Has consideration been given to how often the audit committee should meet to satisfy its responsibilities on a timely basis? Regard may be given to factors such as the annual and interim financial reporting processes, the audit committee’s role in the entity meeting certain market disclosure obligations (e.g. any continuous disclosure obligations), the complexity of the business, and assessing whether non-audit services provided by an auditor may compromise their independence. In some cases, ad hoc meetings, teleconferences or email exchanges may also be considered.
Does the audit committee have a mandate that permits it to carry out its responsibilities free of any unreasonable restraints?
Does the audit committee have support of a secretary or other appropriate resources for its role?
Does the audit committee have sufficient capacity for its roles, and to be effective in its role in relation to financial reporting and audit quality?
Is there an open internal dialogue within the audit committee?
Are all audit committee members encouraged to ask questions, express their views, be heard and have their views considered?
Is the audit committee the key representative body with which the external auditor interacts?
Does the audit committee report to the full board on the audit committee’s activities to support audit quality, including how issues raised by the auditor were addressed?
Does the audit committee conduct peer assessments of the performance of each of its members and assessments of its own effectiveness?

How can directors and audit committees promote audit quality?

To ensure audit quality, directors and audit committees may consider certain good practice matters when:

recommending the appointment of an auditor to members
assessing potential and continuing auditors
facilitating the audit process
communicating with the auditor
maintaining auditor independence
assessing audit quality.

The matters that may be considered are listed as questions under each area. They may also be included in some form in the audit committee’s charter.

Recommending the appointment of an auditor

Matter	Considerations
Any audit tender or other selection process	Is any audit tender or other selection process being conducted independently of company management (i.e. using a panel of non-executive directors)? Are the audit tender or selection criteria focused on audit quality and are they set at the start of the tender/selection process? Are potential auditors assessed against the criteria and selected having regard to audit quality, including skills, expertise, technical competence, industry knowledge, and resource capacity? Are eligible firms given appropriate access to management to understand the business and key risk areas so as to determine the nature, timing and extent of audit work, as well as the resources and expertise required for the audit? Are reduced fees likely to compromise audit quality (e.g. by inadequate resourcing or insufficient work being performed)? Have separate tender documents relating to audit quality and to fees been obtained, and the document relating to quality been considered before reviewing the proposed fees? Does the process ensure that potential auditors are not asked for their views on contentious judgements or accounting treatments before their selection (also known as ‘opinion shopping’)? Are potential auditors asked to confirm that they are not aware of any matters that could affect their independence? Has the audit committee satisfied itself that the chosen auditor is independent in accordance with the law and applicable standards? Has consideration been given to whether the incumbent auditor is overly familiar with management? When considering a change in auditor, have any unusual circumstances that could compromise audit quality (beyond the need for an incoming auditor to invest time to understand the business and risks) been considered?
Commitment to audit quality	Has the auditor (including any incumbent auditor) demonstrated a commitment to audit quality and is there a culture within their firm that promotes audit quality? Has any information relevant to audit quality in the audit firm’s annual audit transparency report been reviewed? How is the auditor addressing any general overall findings reported publicly by ASIC from audit firm inspections or from the firm’s own internal quality reviews?

Matter

Considerations

Any audit tender or other selection process

Is any audit tender or other selection process being conducted independently of company management (i.e. using a panel of non-executive directors)?
Are the audit tender or selection criteria focused on audit quality and are they set at the start of the tender/selection process?
Are potential auditors assessed against the criteria and selected having regard to audit quality, including skills, expertise, technical competence, industry knowledge, and resource capacity?
Are eligible firms given appropriate access to management to understand the business and key risk areas so as to determine the nature, timing and extent of audit work, as well as the resources and expertise required for the audit?
Are reduced fees likely to compromise audit quality (e.g. by inadequate resourcing or insufficient work being performed)?
Have separate tender documents relating to audit quality and to fees been obtained, and the document relating to quality been considered before reviewing the proposed fees?
Does the process ensure that potential auditors are not asked for their views on contentious judgements or accounting treatments before their selection (also known as ‘opinion shopping’)?
Are potential auditors asked to confirm that they are not aware of any matters that could affect their independence?
Has the audit committee satisfied itself that the chosen auditor is independent in accordance with the law and applicable standards?
Has consideration been given to whether the incumbent auditor is overly familiar with management?
When considering a change in auditor, have any unusual circumstances that could compromise audit quality (beyond the need for an incoming auditor to invest time to understand the business and risks) been considered?

Commitment to audit quality

Has the auditor (including any incumbent auditor) demonstrated a commitment to audit quality and is there a culture within their firm that promotes audit quality?
Has any information relevant to audit quality in the audit firm’s annual audit transparency report been reviewed?
How is the auditor addressing any general overall findings reported publicly by ASIC from audit firm inspections or from the firm’s own internal quality reviews?

See also Assessing potential and continuing auditors for other matters that may be relevant.

Assessing potential and continuing auditors

Matter	Considerations
Resources devoted to the audit	For a continuing auditor, have they prepared a high-level plan for the audit for review by directors and the audit committee? What level of resources will the auditor devote to the audit? Does the auditor demonstrate a sufficient understanding of the business, the industry and environment in which it operates, risk areas and key issues relevant to the financial report, and do they plan to respond appropriately to assessed risks? (In a tender process, sufficient access would normally be provided to management.) Do the auditor’s engagement partner, review partner and audit team members have sufficient experience and expertise, given the size and complexity of the company and its operations? This includes relevant industry expertise, and valuation expertise (including from third-party experts directly engaged by the auditor) appropriate for the types of assets, liabilities and exposures of the company. Will the senior audit team members (particularly the engagement partner) be sufficiently involved in the audit? Are the firm’s arrangements for supervising and reviewing the audit, and internal firm quality reviews and controls, adequate (including in connection with foreign and domestic component audits)? Has the auditor demonstrated their ability and capacity to adequately cover audit work in geographical locations in which components of the company’s group operate?
Reliance on experts and other auditors	Will the auditor directly engage their own firm or external experts to supplement the audit team’s experience and expertise in specialist areas (e.g. for complex asset and financial instrument valuations, or using specialists such as geologists or actuaries, or information technology (IT) system experts) to obtain an independent view on the work of company management and any external specialists engaged by the company? Will the auditor use the work of other auditors and coverage of components within a group (e.g. local or foreign branches, and subsidiaries)? If so, how will they satisfy themselves on the qualifications and work of other auditors? Will the auditor rely on internal auditors to perform external audit work? (External auditors may rely on internal audit as part of internal controls and to identify risks. However, independence is essential to investor and market confidence in the external audit, and internal auditors may not be seen as fully independent as they are employed by the company.)
Audit strategy and scope	Has the auditor prepared a plan for the audit for discussion with the audit committee that includes the audit strategy and scope? Does the auditor plan to address risks known to audit committee members? Is the coverage and planned work of component auditors at significant operations or locations appropriate? Will the auditor review and rely on systems and controls in performing the audit, particularly where there are large numbers of systematically processed transactions, and are matters such as the auditor’s system rotation plan, proposed reviews of IT controls adequate and appropriate?
Accountability	Are the auditor’s engagement partner, review partner, specialists and audit team members appropriately accountable for audit quality?

Facilitating the audit process

Matter	Considerations
Supporting the audit	Is audit quality likely to be compromised by reduced audit fees that might result in the audit being inadequately resourced or insufficient work being performed? Do audit fees reflect changes in risks, new businesses, new complex transactions, etc? Have financial reporting processes and audit processes been planned to ensure that an effective quality audit can be conducted within the financial reporting deadlines? Have any concerns or risks highlighted by the auditor, including concerns about systems, processes or policies that could materially affect future financial reports, been considered and addressed?
Company management and staff	Do management and the company have a culture focused on financial reporting quality? Is there appropriate accountability and incentives for company management and staff to focus on the quality of financial reporting, timely reporting and facilitation of the audit process? Has company management given the auditor all information and explanations that may be relevant to the financial report and audit in a timely manner? Do company management and staff have a positive and helpful approach to the audit process?

Matter

Considerations

Supporting the audit

Is audit quality likely to be compromised by reduced audit fees that might result in the audit being inadequately resourced or insufficient work being performed?
Do audit fees reflect changes in risks, new businesses, new complex transactions, etc?
Have financial reporting processes and audit processes been planned to ensure that an effective quality audit can be conducted within the financial reporting deadlines?
Have any concerns or risks highlighted by the auditor, including concerns about systems, processes or policies that could materially affect future financial reports, been considered and addressed?

Company management and staff

Do management and the company have a culture focused on financial reporting quality?
Is there appropriate accountability and incentives for company management and staff to focus on the quality of financial reporting, timely reporting and facilitation of the audit process?
Has company management given the auditor all information and explanations that may be relevant to the financial report and audit in a timely manner?
Do company management and staff have a positive and helpful approach to the audit process?

Communicating with the auditor

The quality of communications between directors and audit committees and the auditor is important in supporting audit quality. This communication should include concerns and risks affecting the processes that support the information in the financial report, and how these concerns and risks are being addressed by directors and management and responded to in the audit.

Two-way communication between the auditor and directors helps the auditor to obtain information that is relevant to the audit and assists directors in overseeing the financial reporting process.

Communication between the auditor and the audit committee must not undermine the auditor's independence or the effective performance of the audit or auditing procedures.

Matter	Considerations
Addressing any risk areas or areas of concern	Is the auditor informed in a timely manner of any areas of risk or concern (including accounting treatments, accounting estimates, complex new transactions, matters raised by regulators, and issues with accounting records or processes/controls) that are relevant to the financial report and audit? Is the auditor informed about any inquiries or concerns raised by regulators or market operators with accounting treatments, accounting estimates or any other matter that could have an impact on financial information reported to the market? Does the auditor provide written reports on key issues and concerns, and have any reports been considered and acted upon appropriately? Do directors and the audit committee challenge the auditor, including on professional scepticism applied in judgement areas such as accounting estimates and accounting policies?
Ensuring access to directors and audit committee	Is the auditor invited to attend all audit committee meetings, except when the audit committee is discussing the auditor’s performance? Is there an open dialogue between the auditor and the directors and audit committee on matters affecting the financial report, the audit and audit quality? Does the auditor meet with the directors and the audit committee, without company management present and without any minutes of the discussions being shared with management? Does the auditor have open access to the audit committee chair without company management present, outside of the formal audit committee meetings?

Matter

Considerations

Addressing any risk areas or areas of concern

Is the auditor informed in a timely manner of any areas of risk or concern (including accounting treatments, accounting estimates, complex new transactions, matters raised by regulators, and issues with accounting records or processes/controls) that are relevant to the financial report and audit?
Is the auditor informed about any inquiries or concerns raised by regulators or market operators with accounting treatments, accounting estimates or any other matter that could have an impact on financial information reported to the market?
Does the auditor provide written reports on key issues and concerns, and have any reports been considered and acted upon appropriately?
Do directors and the audit committee challenge the auditor, including on professional scepticism applied in judgement areas such as accounting estimates and accounting policies?

Ensuring access to directors and audit committee

Is the auditor invited to attend all audit committee meetings, except when the audit committee is discussing the auditor’s performance?
Is there an open dialogue between the auditor and the directors and audit committee on matters affecting the financial report, the audit and audit quality?
Does the auditor meet with the directors and the audit committee, without company management present and without any minutes of the discussions being shared with management?
Does the auditor have open access to the audit committee chair without company management present, outside of the formal audit committee meetings?

Maintaining auditor independence

Matter	Considerations
Independence and objectivity	Is there a policy on the auditor's independence? If the auditor performed any non-audit services, were these reviewed and approved before the auditor was engaged, to ensure their independence is not compromised? Have audit team members avoided becoming too close to company management, which can affect independence and objectivity? Have the directors and audit committee members formed their own views on complex accounting policy choices or estimates, including seeking independent third-party advice, rather than relying on the views of the auditor? Have any other matters that may affect the independence and objectivity of the auditor been considered? Has the auditor explained the basis for their independence declaration?

Matter

Considerations

Independence and objectivity

Is there a policy on the auditor's independence?
If the auditor performed any non-audit services, were these reviewed and approved before the auditor was engaged, to ensure their independence is not compromised?
Have audit team members avoided becoming too close to company management, which can affect independence and objectivity?
Have the directors and audit committee members formed their own views on complex accounting policy choices or estimates, including seeking independent third-party advice, rather than relying on the views of the auditor?
Have any other matters that may affect the independence and objectivity of the auditor been considered?
Has the auditor explained the basis for their independence declaration?

Assessing audit quality

Directors and audit committees are well-placed to evaluate an auditor's performance, and can help to ensure that members receive a valuable independent audit opinion on the financial reports. This promotes market confidence in the company’s financial reports.

Matter	Considerations
Quality and standards	Has the auditor demonstrated a commitment to audit quality, and the application of high ethical standards?
The audit process	Did the auditor demonstrate a sufficient understanding of the business, operations and risk areas relevant to the financial report, and have they responded appropriately to assessed risks? Did the auditor exhibit sufficient professional scepticism in challenging, rather than rationalising, estimates and accounting policy choices (e.g. complex or subjective asset valuations, including cases where the reported net assets exceed the market capitalisation of the company)? Has the auditor addressed risks or concerns identified by the directors and audit committee?
Communication of issues	Did the auditor raise key issues affecting the financial report in a timely manner? Did the auditor raise relevant and useful comments in their management letters?
Other information	Has information relevant to audit quality in an audit firm’s annual audit transparency report been reviewed? Has any other information on audit quality been reviewed (e.g. internal company staff observations or assessments of audit quality)? Can the auditor take any actions to improve audit quality? If so, are measures and timetables in place to track progress of these actions?
Findings from ASIC’s audit inspections and surveillances	If ASIC (or other regulators) selected the company’s audit for review, have the directors and audit committee considered the review’s scope and results? Have any findings from the review been addressed? If the auditor indicated these findings were not significant (e.g. mere documentation matters), have the directors and audit committee challenged this, given ASIC does not report insignificant findings? Have any overall public aggregate thematic findings from ASIC’s inspections or surveillances that are common across many audits and firms been addressed by the auditor?

What are the possible reporting considerations for directors?

Directors might wish to consider whether to comment publicly on the role of the directors and audit committee in supporting audit quality. For example, they might discuss how the directors and audit committee supported audit quality when recommending the appointment of auditors, assessing the auditor’s ongoing performance or reviewing audit fees. These comments could, for example, accompany the annual financial report or be made available in a statement on the company’s website.

Where can I get more information?

Auditing and Assurance Standards Board – for copies of auditing standards.
RG 260 Communicating findings from audit files to directors, audit committees or senior managers
INFO 183Directors and financial reporting
Contact ASIC on 1300 300 630.

Important notice

Please note that this information sheet is a summary giving you basic information about a particular topic. It does not cover the whole of the relevant law regarding that topic, and it is not a substitute for professional advice. We encourage you to seek your own professional advice to find out how the applicable laws apply to you, as it is your responsibility to determine your obligations.

You should also note that because this information sheet avoids legal language wherever possible, it might include some generalisations about the application of the law. Some provisions of the law referred to have exceptions or important qualifications. In most cases, your particular circumstances must be taken into account when determining how the law applies to you.

Information sheets provide concise guidance on a specific process or compliance issue or an overview of detailed guidance.

This information sheet was reissued in October 2021.